What is a fixed term annuity and should I get one?

If you like the idea of a regular income in retirement, but don’t feel ready to commit to a lifelong commitment, then a fixed-term annuity could be a good option.

Sometimes called short-term annuities, these products last from one to 25 years, although five to 10 years is typical.

Unlike a standard annuity, which pays guaranteed income for life, a fixed-term annuity gives you the opportunity to get a guaranteed income for a set period, so you can reassess your options when it ends.

What is a fixed-term annuity?

A fixed-term annuity is an insurance product that pays you a guaranteed income for a set amount of time, followed by a lump sum, known as a ‘maturity sum,’ paid when the annuity ends.

You are then free to look at other pension options with the cash, such as buying another annuity or opening a drawdown scheme.

Who is a fixed-term annuity suitable for?

A fixed-term annuity works well if you need income for a defined period rather than for life.

Common examples include bridging the gap before your State Pension starts, or replacing part of your salary if you reduce your working hours ahead of full retirement.

It suits people who want guaranteed income now but aren't ready to commit their whole pension pot to a lifetime product.

How do fixed-term annuities work?

When you buy a fixed-term annuity, you pay a lump sum in return for a regular retirement income.

You can usually decide whether you receive income monthly, quarterly or annually.

The income you receive will depend on:

• The amount you pay for your annuity.

• Your provider’s annuity rates.

• The length of the annuity.

• Personal factors such as your age and state of health.

At the end of the fixed term you have chosen, you will usually receive a lump sum known as the ‘maturity sum.’ 

This sum is made up of the money you paid originally, as well as investment growth minus the income you’ve already received. 

In most cases, this maturity sum is agreed at the outset, so you won’t be left with a surprise if the stock market doesn't perform as well as expected.

In some cases, the maturity sum may be tied to investment performance. You can choose the amount of income you have paid to you, and this decision directly affects the maturity sum you receive.

If you choose to have a lower annuity income, you’ll receive a higher maturity sum and vice versa.

What happens to a fixed-term annuity if I die?

If you die before your fixed-term annuity ends, the remaining funds are usually paid to a named beneficiary, such as a spouse or family member.

The procedure for this can vary by provider and may also depend on the specific product you buy, so it’s advisable to seek financial advice.

You can also choose products where the payments continue after death for a period of time.

How are fixed-term annuities taxed?

Any annuity payments you receive will be taxed in the same way as normal income.

However, you can usually take up to 25% of your pension as a tax-free lump sum or a series of lump sums before buying an annuity.

Taking this money out tax-free rather than using it to buy an annuity is usually a more tax-efficient way to spend your retirement money.

What are my options with a fixed term annuity?

Fixed-term annuities have a number of flexible features.

For example you can choose:

• The term (most are between five and 10 years)

• Whether to have a single or joint life policy (to cover a spouse or partner)

• Between a level or inflation-linked income

• Additional death benefits

How do I buy a fixed term annuity?

When considering a fixed-term annuity, always shop around. 

Different providers will offer different fixed-term annuity rates, and the right choice can boost your income by thousands of pounds over the longer term.

Fixed-term annuity rates indicate how much you will receive each year for every £100,000 you invest.

For example, if you are offered a rate of 5% and you pay £70,000, you will receive £3,500 a year (followed by the maturity sum at the end).

You can apply to providers directly, but a financial adviser can help you choose the right product and ensure it is set up in a way that works within your wider retirement income plan.

How long is a fixed-term annuity quote valid for?

Once you get a quote, providers typically only guarantee that rate for a set period, often around 30 to 45 days.

If you don't buy within this window, you may need a new quote, and the rate could have moved. It's worth having your pension details ready in advance so you can act quickly once you find a rate you're happy with.

What are the pros and cons of fixed-term annuities?

To help you decide if a fixed-term annuity is the right option for you, it's important to weigh up the advantages and disadvantages.

What are the pros of fixed-term annuities?

• Flexibility: You can tailor the product to suit you, and you’re not tied in for the rest of your life.

• Security: You’ll receive retirement income each year and for a set amount of time. You’ll also know how much you’ll get back at the end of the term.

• You will have the chance to earn more: At the end of the term, you could take out a new product at a better rate or benefit from an enhanced annuity if your health has deteriorated.

What are the cons of fixed-term annuities?

• You could receive less than you hoped for: If the product you opt for does not come with a guaranteed maturity value, you could receive less at the end of the term than expected if your investment underperforms.

• Inflation could rise: Unless you add inflation protection, you may find that the income you receive isn’t enough to live on if the cost of living rises substantially.

• Exit fees: If you decide to move your money before the end of the term, it’s likely you’ll be penalised.

• It might not always be cost-effective: You might get more for your money with a different investment.

As with all investment products, fixed-term annuities come with risks.

A financial adviser can help you work out what is best for you.

Get expert financial advice

A fixed-term annuity can offer a blend of security and flexibility - helpful if you want a steady income without losing the ability to reassess your plans at a later date.

However, it's important to understand the impact of annuity rates and the rising cost of living on your decision.

By carefully considering your options and seeking professional advice, you can determine whether a fixed-term annuity is the right fit for your retirement strategy.

Unbiased can quickly match you with a financial adviser for expert financial advice to help you navigate the complexities of fixed-term annuities and ensure they align with your long-term financial goals.